Graham Q3 2024 Earnings Call Transcript

Quartr
Provided by Quartr
February 5, 2024

There are 8 speakers on the call.

Operator

Greetings. Welcome to the Graham Corporation Third Quarter Fiscal Year 20 24 Financial Results Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. Please note this conference is being recorded.

Operator

I will now turn the conference over to Deborah Pawlowski, Investor Relations for Graham Corporation. Thank you. You may begin.

Speaker 1

Thank you, Daryl, and good morning, everyone. We certainly appreciate your time today and your interest in Graham Corporation. With me on the call are Dan Thorne, our President and CEO and Chris Thome, our Chief Financial Officer. Dan and Chris are going to provide their formal remarks, after which we will open the line for questions. You should have a copy of the Q3 fiscal 2024 financial results that were released this morning.

Speaker 1

And if not, you can access the release on our website at ir.gramcorp.com. You'll also find there the slides that will accompany today's discussion. If you will turn to Slide 2 on that deck, I will review the Safe Harbor statement. You should be aware that we may make some forward looking statements during the formal discussion as well as during the Q and A session. These statements apply to future events are subject to risks and uncertainties as well as other factors that could cause actual results to differ materially from what is stated here today.

Speaker 1

These risks and uncertainties and other factors are provided in the earnings release as well as with other documents filed by the company with the Securities and Exchange Commission. You can find those documents on our website or atsec.gov. During today's call, we will also discuss some non GAAP financial measures. We believe these will be useful in evaluating our performance. However, you should not consider the presentation of this additional information in isolation or as a

Operator

substitute for results prepared in accordance with GAAP.

Speaker 1

We have provided for results prepared in accordance with GAAP. We have provided reconciliations of non GAAP measures with comparable GAAP measures in the tables that today's release and slides. We also use key performance indicators to help gauge the progress and performance of the company. These key performance metrics are orders, backlog and book to bill ratio. They are operational measures and the company's methodology for calculating these numbers does not meet the definition of a non GAAP measure as that term is defined by the SEC.

Speaker 1

So as a result, a quantitative reconciliation Each of these is not required or provided, but you can find the disclaimer regarding our use of key performance metrics at the back of our deck in the supplemental slide. So with that, if you would please advance to Slide 3, I will turn it over to Dan to begin. Dan?

Speaker 2

Thanks, Debbie, and good morning, everyone. Reflecting on the past few years, we firmly believe that Our business is now in a significantly improved position due to the strategic actions that we've taken. This has been a great team effort. And I would like to thank our customers, our employees and our service providers for their contribution to our turnaround. In the Q3, our performance demonstrated robust strength, underscoring the consistent execution of our strategic approach aimed at cultivating high quality top line growth along with margin accretive initiatives to enhance our future earnings potential.

Speaker 2

Notable highlights from the quarter gross and adjusted EBITDA margin expansion, a substantial increase in bookings that led to a record back of nearly $400,000,000 and we refinanced our debt with a lower cost and more flexible credit facility, further solidifying our financial framework. Our bottom line was muted, however, given some atypical expenses that Chris will talk to, but on an adjusted basis, net income was up over 180 percent to $2,400,000 We generated strong cash from operations during the quarter given recent working capital initiatives along with stronger financial discipline. This enabled significant debt pay down during the quarter and strategic investments both organic and inorganic. We highlight on Slide 4, A significant investment made during the quarter, which was the acquisition of P3 Technologies. This was a great bolt on business, which brings highly complementary technology that enhances and expands our Turbomachinery Solutions, engineering and development team.

Speaker 2

Their patented technologies deepen our reach into existing space and new energy markets and create greater diversification with the addition of medical markets. From a financial perspective, P3 brings about $6,000,000 of annual revenue, accretive gross and adjusted EBITDA margins and approximately $6,000,000 of backlog. They also have what we feel is a lot of high growth pipeline opportunities that are highly complementary to our Barber Nichols Turbomachinery business. In fact, in the short period that they have been with us, That business has already proven instrumental in fortifying some of our solution offerings and has amplified our financial profile, including being accretive to earnings in the 3rd quarter. It is important to note that given this quarter's robust cash generation, We were able to repay nearly all of the debt associated with the acquisition during the Q3.

Speaker 2

Together, we believe we have a bright future as we aim to create opportunities for product and technology integration to provide more effective solutions across multiple markets. As we look forward, we are focused on advancing Gram By building a collaborative culture across our brands, leveraging best practices and advancing employee development to reinforce Our core capabilities of precision machining of critical turbomachinery components and specialty welding for fabrication of critical equipment for large heat transfer and vacuum applications. Our confidence remains high in our ability to consistently execute our strategy and leverage the multitude of opportunities before us. With that, let me turn it over to Chris for the financial details. Chris?

Speaker 3

Thank you, Dan, and good morning, everyone. As Dan highlighted, our results for the quarter include approximately 2 months of operation from P3, which was acquired on November 9, 2023. On slide 5, you can see that we had a strong growth for our Q3 of fiscal 2024 with sales of $43,800,000 This was up 10% or $3,900,000 over the prior year and included approximately $1,000,000 of incremental sales from P3. Strong sales in the commercial aftermarket continued to help offset the cautious spending on capital projects in the refining and petrochemical industries. Aftermarket sales were $8,600,000 in the quarter, up $3,200,000 or 59% over the Q3 of last year.

Speaker 3

Defense revenue was also solid with an increase of $2,600,000 or 12% reflecting higher price contracts as well as increased capacity in direct labor hours. We did see a decline in the space market, which had a lot to do with project timing as we had strong order growth during the quarter I will talk to in a few slides. We are still seeing the impact of the Virgin Orbit bankruptcy last year, but should finally cycle through that once we finish out fiscal 2024. P3 helped offset some of this decline And we expect further lift from that acquisition within this industry mix, as well as a robust pipeline of other opportunities in the new energy, and Medical Markets. U.

Speaker 3

S. Sales for the quarter were 84% of total revenue and continue to reflect the size and growth of our defense business. Looking to the chart on the right, Gross profit was another positive story with an increase of $3,500,000 or 56 percent to $9,700,000 in the 3rd quarter. The 660 basis point expansion of gross margin reflected higher volume and the related improved absorption. Mix also played a role with higher margin commercial aftermarket sales as well as the margin accretive sales from P3.

Speaker 3

And lastly, we are benefiting from improved execution and pricing on defense contracts. Turning to Slide 6, you can see our bottom line and adjusted EBITDA results. As Dan mentioned, net income was impacted by a number of items this past quarter. SG and A excluding amortization was $8,400,000 or 19 percent of sales, up from 13% of sales during last year's period. The increase reflects higher performance based compensation, including a $1,300,000 supplemental performance bonus for Barber Nichols employees in connection with the 2021 acquisition.

Speaker 3

Also contributing to the increase in SG and A was P3 related costs, increased professional fees largely related to our international operations and initial ERP conversion costs. Separately, on the income statement, you will also see a line item for our costs associated with the debt during the quarter, which amounted to $700,000 When excluding many of these atypical costs On a non GAAP basis, adjusted net income was $2,400,000 or $0.22 per diluted share, up 183% from a year ago. Similarly, you could see the improvements in adjusted EBITDA, which grew 72% to $3,900,000 or 8.8 percent of sales, up 3 20 basis points. Turning to Slide 7, you could see how a strong quarter of cash generation enabled us to further improve our balance sheet, while still making strategic investments. At the beginning of the quarter, we refinanced all of our outstanding debt with a new 5 year $50,000,000 revolving credit facility that matures in 2028.

Speaker 3

This facility provides us with reduced borrowing costs and greater to fund our long term strategic growth goals. Cash generated from operations in the Q3 was $7,600,000 $19,500,000 for the year to date period of fiscal 2024. We utilized some of this cash to reduce our debt balance by $7,900,000 to $3,000,000 atquarterend. P3 was acquired with a combination of cash, stock and contingent earn out based upon the future performance of P3. As Dan highlighted, most of the debt associated with the acquisition was paid off during the quarter.

Speaker 3

However, in January 2024, After the quarter ended, we paid off the remaining $3,000,000 of debt currently leaving us debt free. Capital expenditures of $1,900,000 in the quarter $5,200,000 year to date were focused on capacity expansion, productivity improvements and the start of the ERP implementation at our Batavia facility. In total, we expect the ERP project to cost approximately $2,000,000 in capital $1,000,000 in expense with an anticipated go live date of about a year from now. We decreased our expected fiscal 2024 capital expenditures now be in the range of $8,000,000 to $10,000,000 primarily due to the projected timing of cash flows. All projects continue to move forward at a steady and thoughtful pace.

Speaker 3

If you turn to Slide 8, During the quarter, we had record orders of over $123,000,000 which were up 6 times over the prior year and resulted in a book to bill ratio of 2.8. These were largely follow on orders for critical U. S. Navy programs, Although aftermarket orders for the refining and petrochemical markets remained strong at 7,800,000 We also saw nice order flow from our space customers of $6,100,000 which was up $4,500,000 year over year and doubled the sequential quarter and remains a key growth driver in our diversified portfolio. Turning to slide 9, you'll see that our backlog is nearly $400,000,000 also a record level, which provides several years of visibility given the long lead times of some of our defense contracts.

Speaker 3

The P3 acquisition added $6,000,000 to our backlog. Approximately 40% of our backlog is expected to convert to sales in the next 12 months and another 25% to 30% is expected to convert to sales over the next 1 to 2 years. The majority of our orders that convert beyond 12 months are for the defense industry, specifically the U. S. Navy.

Speaker 3

Turning to slide 10, we can review our guidance for fiscal 2024. Given our strong performance year to date and the addition of P3, we have raised our revenue expectations to be between 100 $75,000,000 $185,000,000 for fiscal 2024, up $5,000,000 at the bottom and top end. This implies top line growth over fiscal 2023 of 15% at the midpoint of that range. From a margin perspective, our gross margin guidance is approximately 20%, up from the 18% to 19% we guided last quarter. Additionally, our expectations for SG and A including amortization to be between 16% to 17% of sales, up 1 percentage point over our previous guidance.

Speaker 3

This includes costs associated with the supplemental performance bonus for our Barber Nichols employees, the P3 acquisition costs as well as ERP implementation expenses at our Batavia facility. We also raised our adjusted EBITDA guidance for fiscal 2024 to range between $15,000,000 to $16,000,000 up from our previous guidance of $11,500,000 to $13,500,000 The new range implies an adjusted EBITDA margin of about 9% at the midpoint. I should point out that our Adjusted EBITDA guidance excludes the SG and A items I just mentioned and approximately $700,000 of debt extinguishment charges. We are delivering continuous improvement and are on track to achieve our fiscal 2027 goals. We continue to expect 8% to 10% annualized organic growth per year, which implies $225,000,000 to $240,000,000 in revenue for fiscal 2027.

Speaker 3

And with margins improving steadily, we are on target to achieve our low to mid teen adjusted EBITDA margin goal. With that, I will pass the call back to Dan.

Speaker 2

Thanks, Chris. Significant strides are being made within our organization, yet there remains a lot of work to be done. Our team is devoted to the ongoing pursuit of our strategy for sustained growth and I am grateful for their unwavering dedication, enthusiasm and diligent efforts. Our record backlog and the acquisition of P3 add up to a bright future for Graham. Numerous opportunities lie ahead and we anticipate that these will play a pivotal role in propelling our growth and bolstering our future earnings.

Speaker 2

With that, Daryl, you can open the call for questions.

Operator

Our first questions come from the line of Theodore O'Neil with Litchfield Hills Research. Please proceed with your questions.

Speaker 4

Thank you and congratulations on the good quarter. Thanks, Bill. Dan, in your prepared remarks You mentioned that there was a pipeline of high growth opportunities that was part that you got as part of P3 acquisition, I was wondering if you could give us some more detail on that?

Speaker 2

Yes. They're mostly on the space side. And I probably won't be able to give you a whole lot of detail there just because of NDAs, But P3 has been working in propulsion pumps, fluid management pumps for space applications. So they're actually an awesome compliment to Barber Nichols from that perspective and really probably deepens our engagement with the space community. The other thing I get excited about P3 is they're also involved in some of the new energy, waste power gen types of applications.

Speaker 2

And then they do cryogenic pumps, which really get into some of the medical applications that they're trying to apply those to. And then they've got some very cool IP that we believe we haven't scratched the surface on that yet as far as how and when we would like to take that to market, That's definitely something we're pretty excited about. And one of those is what they call a multi channel diffuser, which is an efficiency enhancement that can be applied to basically any pump pumping liquids and so we're pretty excited about that. And then their cryogenic pump capability really complements again Barber Nichols That is mostly centrifugal types of pumps and P3 brings a positive displacement pump that Complements that. So lots of really cool things and Phil and his team are top notch engineers and we're really, really excited to have them.

Speaker 4

Okay. And Chris, in the press release, you say that the Improved working capital was largely due to changes in payment terms related to large defense customer. Can you give us any more detail on that, what that means?

Speaker 3

Sure. So for the last couple of years, the team has actively been working on putting in stronger discipline with regards to capital management. Basic blocking and tackling, collecting receivables sooner, pushing out payment terms where possible. And several of our large defense contracts had really unfavorable payment terms where basically once you got Past 50% production, you couldn't bill anymore until project completion. Well, as you know, some of these projects can go on for several years.

Speaker 3

So that was really putting a cash restraint on our business. And over the past, I would say 3 to 4 quarters, we were able to renegotiate some of the payment terms where we're now billing more milestones and more on a percentage complete basis. So that really provided significant uplift to the cash generation over the last couple orders. Additionally, as you know, with the $123,000,000 of orders that we had this quarter and then a large amount of defense orders over the last year. A lot of those pay for the materials upfront.

Speaker 3

So we've been able to cash collect that cash upfront, but we'll have to pay for that inventory as it comes in. So As we've discussed in the past, we fully expect our cash generation from quarter to quarter to be pretty lumpy. But the team has done an excellent job, really improving some of the payment terms and helping that cash flow along.

Speaker 4

Okay. And given the growth that you're experiencing there, are there any potential CapEx expenditures that you'll need to make or have to make investments in skilled employees to keep up with it all?

Speaker 3

Yes, definitely. As you know, we've guided for CapEx of $8,000,000 to $10,000,000 for this year, which is about 5% at the mid point of the guidance. When we think that our CapEx spend is going to be in the 3% to 5% range over the next several years just to support that growth in the facility expansion that you just mentioned. So yes, we certainly expect Capital expenditures remain elevated for a few years here.

Speaker 4

Okay. Thanks very much.

Operator

Thank you. Our next questions come from the line of Dick Ryan with Oak Ridge Financial. Please proceed with your questions.

Speaker 5

Thank you. Congratulations also on the great quarter guys.

Speaker 2

Thanks Dick. Thanks Dick.

Speaker 3

Thanks Dick.

Speaker 5

Chris looking at the OpEx Your leverage gets a little obscured with all the puts and takes in this quarter. You still guide to that 16%, 17% -ish range for this year. I know you're not providing guidance for 25 yet, but is there any reason to think that kind of the SGA level If this percent of sales changes materially with your aspirational goals going into 27% or Will we start seeing the leverage kind of kick in over the next few quarters?

Speaker 3

Sure. Well, thanks for the question, Dick. As I outlined in my comments today, we had some unusual items in the quarter with regards to SG and A. We've been recording the Barber Nichols earn out bonus for the last several quarters. Had some elevated acquisition costs as a result of the P3 acquisition.

Speaker 3

Professional fees were a little related to our foreign subsidiaries. And then as you know, we've kicked off the ERP implementation. So talking to those items, the Barber Nichols performance bonus is going to be with us for several years. As we've discussed on other calls, It's a 3 year program for fiscal 2024, 2025 and 2016. So that's going to be around for a while here.

Speaker 3

The ERP implementation really just kicked off in the current quarter, in earnest. So As I mentioned in my prepared remarks today, we expect that to be about $1,000,000 of expense over the next year. So I would expect SG and A to be a little bit elevated for the next year here as we work through these things. But then yes, you're Certainly right. The leverage should kick in and by the time we get to 2027, it should allow us to get to those in lowtomidteen EBITDA margin percentages.

Speaker 5

Okay. Thank you. Say, Dan, the strength you've seen in aftermarket the last few quarters, is that still kind of a potential precursor of what you might see on capital budgets in Refining and petrochemical or what's your view of those end markets?

Speaker 2

Yes. So I guess 1st of all, the aftermarket is remaining strong. So we're still seeing that elevated order level continuing on. We are seeing and hearing about some nice capital projects that our customers are planning for this year and we're starting to bid on. So we're encouraged, But again, it will not be the big boom, I think like Graham has seen in the past.

Speaker 2

So we're encouraged. We're happy that the aftermarket continues on strong And we're getting ready to if there is a significant uptick, we've been working pretty hard as far as training new employees at our businesses And the supply chain challenges are starting to work out and less of an issue there. So I think that we're going to be in a pretty position, if and when that does take off.

Speaker 5

I think Chris mentioned some increased professional fees in your international operations, does that reflect you said maybe some of these early capital project discussions or is that something else?

Speaker 3

Yes, I can take that one Dick. As we disclosed in our 10 Q today, Earlier in the year, audit committee received a whistleblower complaint from our India subsidiary. And as a result of that, They launched an investigation, which included hiring outside legal counsel and some forensic professionals. That investigation did confirm the whistleblower complaint, which led to a broader investigation, where other misconduct was identified, mostly with regards to improper expense reimbursements. As we disclosed in the 10 Q, the impact was relatively minor.

Speaker 3

It was about 100 $50,000 in total over 4 years, but that did result in an increased in professional services fees, Probably about $750,000 year to date that we've incurred in that investigation.

Speaker 5

Okay. Okay. So Dan, one of the arguments for P3 was Graham can bring this scope to really expand the potential of both companies. You talked a lot about entering some new market opportunities with P3. When you talk bringing scale to the story, is that broadening the end markets or is there a potential to get deeper into the space business, let's say, when you guys are combining efforts?

Speaker 2

Yes, we see it as both, Dick. So P3 has connections to markets that Barber Nichols doesn't necessarily have. And they've they're a really strong engineering group. And so they're actually bringing some strength on the engineering side to Barbara Nichols also. So we see probably some breadth that comes with P3 doesn't necessarily have the production capabilities that Barbara Nichols has.

Speaker 2

So we're actually going to be able to satisfy P3's customers on the production side also going forward. So I see it as a real win win, in that it is broadening And it's a deepening with some of the technology that P3 brings to the table.

Speaker 5

Great. Thank you.

Operator

Yes. Thank you. Our next questions come from the line of Gary Schwab with Valley Forge Capital Management. Please proceed with your questions.

Speaker 6

Yes. Hi, guys. And just like to say congratulations. Great quarter.

Speaker 3

Thanks, Gary. Thanks, Gary.

Speaker 6

Have you been surprised following up on Dick's question on aftermarket? Have you been surprised by how strong the aftermarket sales have been in the past year?

Speaker 2

To some level, now I don't have a lot of history with So I couldn't tell you what it was like 10 15 years ago. But we do know that in the U. S. Where the majority of our aftermarket comes from that these refineries have been running hard. And They've got to continue to invest in them and keep them properly serviced to be able to keep that high level of output going.

Speaker 2

And so from a demand side, I would say not too surprising just because we're not adding a bunch of new capacity here in this country and you got to keep the existing assets running top performance.

Speaker 6

Okay. Because it's really picked up a lot in the last year. And I know you have an aftermarket sales force That you started. What's the how would they become so successful in closing orders? Are the orders just there?

Speaker 6

Or is it the way you're doing it?

Speaker 2

Well, I think it's both. So certainly the demand is up, just because of the refinery output has been so high for a long time. The other part of it, we have been investing our aftermarket team adding more engineers, readjusted some of the leadership associated with aftermarket and I think that's been positive. We're not done yet. As we kind of think about our installed base internationally, we're trying to figure out how to go after that too.

Speaker 2

And so we've got initiatives with both of our sales offices to figure out the communication strategies relative to life of components and service intervals and things like that. So it is it has been a proactive approach to continue to grow that business. And honestly, I think that we still have quite a bit of room to improve. So we're encouraged in the aftermarket business that we can keep it going. So we'll see.

Speaker 6

Is most of it installed base Or is all of it installed base?

Speaker 2

Yes, pretty much all of it is installed base, yes.

Speaker 6

So the fact that These are all customers of yours that you've delivered product to before. And you talked last quarter about really not having much visibility. Is there a way that you can increase visibility almost like Setting up a subscription business for replacement parts based on predicted wear rates or predicted failure dates?

Speaker 2

Yes, we've got we've actually got a initiative that's starting this week. We've got a kickoff meeting to figure out how to automate using AI is a little bit of a stretch I would say, but automate our approach to aftermarket that uses this installed base, installed base database, Understanding exactly when these things got installed and the typical life associated with the components and starting to automate our market outreach to those installed base customers. So Again, I said, I think that there's quite a bit more we can do. And so We're not resting on our laurels here. We're out there being aggressive and trying to figure out how to go get more.

Speaker 6

Okay. And just one last question for Chris. Is this worth putting a line item on? You have space sales, chemical sales, refinery sales, Defense sales adding aftermarket sales as a line?

Speaker 3

So certainly something we can think about internally here. It's definitely related to the refining and petrochemical market. So it's kind of all encompassing and our disclosure really is by market, which the aftermarket is related to. If anything else, we'd probably in the future look to break out new energy because that's becoming a higher growth and more important part of our business.

Speaker 6

Okay. Because it is the biggest gross margin product that you carry.

Speaker 2

Okay.

Speaker 6

Well, thanks a lot and congratulations again.

Speaker 3

Thanks, Gary. Thanks, Gary.

Operator

Thank you. Our next questions come from the line of John Bair with Ascend Wealth Advisors. Please proceed with your questions.

Speaker 7

Thank you. Good morning. Congratulations, Dan and Chris.

Speaker 2

Thanks, John.

Speaker 7

Very good to see, real pleased to see the debt Out of there and so I got 2 questions, quick questions. One is, contemplation perhaps within the next year or 12 months beyond reinstituting a dividend? And the second question would be With regards to the aftermarket sales, what percentage or roughly what's the breakout between the traditional refining and marketing upgrades versus Biodiesel, which you've said has been in the mix here.

Speaker 3

Yes. John, so let me take the first one with regards to a dividend. As We've already been talking here on the call. We have quite a bit of CapEx that needs to get spent over the next several years. And we have a lot of organic growth opportunities that are in front of us that are well in excess of 20% ROI.

Speaker 3

So those are really our main focus. And then as well as we've really started to try to build out the pipeline with regards to M and A as well and P3 is a great example of the types of opportunities that we'd like take advantage of. So really for the next several years, we're going to be focused on organic growth in M and A and paying down any kind of debt that might come with M and A. So right now, the Board has not made any decision to reinstate that

Speaker 2

And then your question about aftermarket traditional versus biodiesel, Certainly, we've seen an uptick in applications using biodiesel where some of these refineries are getting converted over. I would guess, I don't have that detail As far as what the aftermarket looks like, the installed base is relatively small at this compared to refineries. So I would suspect that the aftermarket is relatively small also. I couldn't quantify that for you other than small in relationship to the refinery aftermarket.

Speaker 7

And what does that aftermarket look like in as far as the international market where you have established An established base of past business?

Speaker 2

Yes, very, very

Speaker 7

Are they on the same cycle? I guess is what I'm getting at is Our industry here, basically, has been running hard. Is that a similar situation internationally?

Speaker 2

Internationally, we're seeing new capacity being brought on. So There's been quite a bit of new capacity in China and India, for instance, and Middle East seems to also be planning on new capacity. And so that continues to grow on the new side. The aftermarket in the installed base internationally has not been a big piece of our business in the past. And as we build that installed base, we have plans to be much more aggressive going after that.

Speaker 2

So, as I had said earlier, we've got initiatives in our sales offices internationally to figure out what that installed base is, where it is and how we go after it in a concerted effort with the Batavia effort here.

Speaker 7

Great. Keep up the good work. Very encouraging. Thank you.

Speaker 2

Thanks, John. Thanks, John.

Operator

Thank you. We have reached the end of our question and answer session. I would now like to turn the floor back over to Dan Thorne for any closing remarks.

Speaker 2

Thank you all for joining us today. I hope that you can sense the excitement we have here at Graham about our future. We will be participating virtually in 2 upcoming conferences, the Gabelli Pump Valve and Water Symposium on February 22 and then the Sidoti Conference on March 14. As always, please feel free to reach out to us at any time and we look forward to talking with you again after our Q4 fiscal 2024 results. Enjoy your day.

Operator

Thank you. This does conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.

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